ARMH: Morgan Stanley Cuts to Hold on Surge in Valuation

By Tiernan Ray

Shares of ARM Holdings (ARMH) are down $1.85, or 4.3%, at $40.58 as the stock receives its second downgrade in two days, based on the stock’s rise in valuation and what may be overly optimistic expectations.

Yesterday, Piper Jaffray’s Gus Richard, cut his rating on the shares to Neutral from Overweight, while maintaining his $40 price target, writing that “While there maybe some upside to estimates, we do not believe it is enough to justify a higher price target” and “even for a dominant franchise, shares are currently fairly valued” at 35 times his 2014 estimates.

Richard’s point is that a payoff on royalties from ARM’s dominance will take time:

While we have little doubt that ARM will be the dominant microprocessor architecture in an increasing number of product categories, world domination takes time. ARM’s most recent product introductions address servers, embedded systems and communication infrastructure. While the licensing portion of the revenue will show up in the model this year, a material impact to the royalty line is many years away.

Today, Morgan Stanley’s Francois Meunier cut his rating to Equal Weight from Overweight, writing “While 12 months ago investors were worried about ARM’s position vs Intel, we believe the current share price implies a near perfect trajectory in ARM’s market share and royalty rate for the next two years.”

Everything hoped for has come true for ARM, writes Meunier, including stuff like Apple (AAPL) introducing the iPadmini, and the ultrabook machines promoted by Intel (INTC) not panning out as expected.

But that means “it will be difficult for news flow to improve from here.”

The stock has returned to a high in terms of its forward P/E, he writes, and “it will be difficult for ARM to grow into its multiples,” he thinks.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.